Cash Flow Isn’t the Same as Profit

Profit isn’t the same as cash flow, but they’re both important to a business’s financial health.

It’s pretty common for new business owners to to point to the profit/loss number on the P&L and think that it has something to do with how much cash their business has. However, cash flow and profit are two very different financial indicators of business health.

So, what’s the difference between profit and cash flow, and how can you use it to help your business?

Part 1 in the Series: Understanding Business Reporting

The Reports in Question:

Two of the main reports that business owners should review each month are the Profit & Loss Statement (also called the Statement of Activity) and the Statement of Cash Flows. They both give you necessary information about the health of the business, but from different perspectives.

What is Profit?

The Profit & Loss statement shows you how much revenue you’ve made, how much you spent in expenses, and the difference between those two. If you earned more than you spent, that’s a profit. If you spent more than you earned, that’s a loss. The profit or loss is what’s commonly known as the bottom line.

Time period is important! The P&L is a report that shows you data over a period of time. People often look at the P&L over months, quarters and years.  It is not, however, a snapshot of a certain moment in time. The P&L also doesn’t include some important cash items that go in and out. So you can’t look at a P&L and determine how much cash you have on a certain day.

One thing to remember is that even though your business may be profitable on the P&L, that doesn’t mean you actually have any cash in the bank. So how do you figure out cash flow?

What is Cash Flow?

Cash flow is money in and money out of a business. It also means how much liquid cash you actually have on hand on any day. Cash flow tells you if you have enough money on hand to pay your bills.

Some people look at their bank balances to get a rough idea of cash flow, but this is of limited use. One good report for tracking this is the Statement of Cash Flows. This report shows all of the cash that is coming in and out of your business. It will show you if there is negative cash flow or positive cash flow during a time period. At Happy Bookkeeping we also do cash flow forecasting to tell you how much money you might have in a month or two.

It’s important to remember that while the P&L doesn’t show all the cash coming in and out of a business, the Statement of Cash Flows does.

So what new information does the Statement of Cash Flows show you? Businesses employ a number of different ways to keep money flowing into their business other than sales, but the P&L just shows sales. Money may also be coming into the business from investments, loans being repaid, or financing (taking out a loan).

The Statement also shows different expenses. Money going out of the business is often regular business expenses or the cost of purchasing inventory, which are both shown on the P&L. However, money going out might also be payments toward debt, or payments to owners, and those are not shown on the P&L.

The Statement of Cash Flows shows ALL the money going in and out, which includes these asset and liability adjustments. Using this report allows you to see a more complete picture of how much cash is coming in and out.

All this is theoretical though. Why don’t we look at a ….

Cash Flow Example

ABC Inc.’s first year in business started off by taking out a loan, because they hadn’t had any sales yet. The company did have a few expenses, and the loan allowed them to pay those while they were looking for their first sale.

ABC Inc. ended up taking a loss (more expenses than income) for six months from January through June, with no income but normal expenses of about $1,500 per month. But in July, the business finally made a huge sale worth $18,000. The income in July was so much that that it paid for all the normal expenses the business had for the entire year. ABC Inc.’s owners decided to pay back half of the January loan with the sale money. They kept the other half for the expenses for the rest of the year.

Another smaller sale in October of $6,000 allowed them more cash for expenses. They also chose to pay another smaller chunk of the loan. However, keeping the year’s monthly cash flow in mind, they held onto some of the loan and the October cash so they could still pay expenses for up to six months in case another sale took time to come through.

If you look at the P&L for ABC Inc for the entire year, it shows a profit of $2,000. After looking at the P&L they decided to cut some expenses so that their profit would be larger, and ended up with expenses of about $1,250 per month instead. They also decided they needed to put more funds toward advertising so they could make more sales.

However, knowing the P&L information alone wouldn’t have allowed them to succeed during their first year. The P&L didn’t show either their loan or loan payments. Knowing their cash flow, on the other hand, gave them the tools to make it through the year.

Example Statement of Cash Flows

The Statement of Cash Flows showed a complete picture of their cash situation. It showed the loan they took out in January, and it showed how the business’s cash was steadily decreasing until June. This is information the P&L wouldn’t tell you.

That’s the difference between cash flow and profit. Cash flow is how much money the business has on hand at any given time. Profit is how much money the company has made over a period of time after you subtract expenses. The moral of the story?

Read your reports!